Abstract

This paper analyzes how political institutions affect the execution of
exchange-rate policy. By focusing on policy-makers’ responses to the
emergence of speculative pressure on their currencies, we argue that the
effect of democratic institutions on exchange-rate stability is likely to be
conditioned by the officially announced exchange-rate regime. Officially
fixed exchange rates are the main instrument of autocrats to signal
commitment to long-term stability. Autocratic governments with strictly
fixed exchange rates are thus more likely to defend their exchange rates
than autocrats with an intermediate regime because the latter implicitly
signal that they care less about monetary stability. In contrast, democrats
defend more often in intermediately than in fully fixed official regimes
by using a combination of external and internal adjustments,
which reduce the negative effects of a devaluation on voters. Our analysis
of 189 currency crises between 1975 and 1999 supports this conditional
effect.